Dear Dr. Dollar:

Each year the U.S. has huge trade imbalances, especially with Asian countries. How can we keep having these trade deficits without any apparent ill effect on our economy? Will we eventually no longer be able to do this? —David J. Harrowe, Chandler, Ariz.

This article is from the March/April 2000 issue of Dollars and Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/2000/0300drdollar.html

Running at about $265 billion dollars, the U.S. trade deficit for 1999 was pretty big, and substantially more than the already large $164 billion of 1998. As the GOP Senate leader in the 1960s, Everett McKinley Dirkson is supposed to have said, “A few billion dollars here, a few billion there, and pretty soon you’re talking real money!”

But so what? What kind of problem or problems, actual or potential, does a large trade deficit present?

A country runs a trade deficit when the value of the goods and services it imports is greater than the value of the goods and services it exports in any given year.

Funds flow out of the country to pay for the imported goods and services, and funds flow in to pay for the exports. But in every year since the mid-1970s, the United States has imported more than it has exported. The trade deficit reached its height relative to the nation’s total output in the mid-1980s, when it equaled about 3.3% of gross domestic product (GDP). Today it amounts to less than 3% of GDP.

Where do the funds come from to pay for this mismatch? Mainly they come from foreign companies and individuals who send money into the United States to invest. Of course there is also money going out of the United States for investment purposes. Yet in recent years, the investment funds coming in have been much larger than the investments going out, offsetting the trade deficit.

For example, in 1998 (the most recent year for which we have complete data), the foreign assets owned by U.S. businesses and wealthy individuals increased by about $300 billion while U.S. assets owned by firms and individuals abroad increased by about $500 billion. This $200 billion excess of investment funds flowing in more than covered the 1998 trade deficit of $164 billion. About $193 billion of the increase in foreign investment in the U.S. was “direct investment”—i.e., firms setting up subsidiaries in the U.S. Another $218 billion was invested in bonds and corporate stocks.

The next piece of the funds-coming-in versus funds-going-out picture comes from “investment income.” In 1998, the United States paid out about $270 billion in interest and profits to foreign investors, and U.S. interests received about $258 billion from overseas investments.

Finally, the last piece of the picture are currency reserves—funds accumulated in U.S. bank accounts from earlier international transactions. When everything is said and done, if we look beyond the trade balance alone, all the funds flowing out and all the funds flowing in equal each other.

The experience of the late 1990s, with the combined large trade deficit and large net inflow of investment funds, was a result of the relatively fast growth of income and output in the United States compared to other countries. As our income grows faster than theirs, our demand for goods they produce (imports) grows faster than their demand for goods we produce (exports). International investors also tended to clamor to put their money into the U.S. because of the strong growth here. On the other hand, in the early 1990s, when U.S. growth was particularly poor (remember the recession of 1991?), the trade deficit shrank to 0.5% of GDP and the net flow of investment into the country also dropped.

Along with the relative rates of economic growth among countries, other factors such as relative interest rates, the nature of governments’ budgeting policies and control of money supply, and politics, all play roles in determining the trade deficit and flow of investment funds. For instance, if a government pays high interest on the bonds it issues to pay for government programs, it will attract foreign investment.

However one explains the situation, it comes down to this: for the past 25 years the U.S. has been living beyond its means, borrowing funds from the rest of the world to finance our purchases of more from other nations than they buy from us.

Is this a problem? It could be if the funds are not used in ways that enhance our ability to repay. Have they added to our ability to invest and create new productive capacity or have foreign funds acted as a substitute for domestic savings? If this last is true—and there is some evidence that this is the case—then paying back the foreign funds will become an increasing burden.

Also, foreign borrowing could present a problem for the United States to the extent that international financial markets are volatile. Were investors to take huge amounts of funds out of the country quickly, financial markets could fall into chaos, relative currency values among countries could be upset, and production could be seriously harmed. Such a scenario might develop were the U.S. economy to experience a severe downturn or if the U.S. government were to sharply lower interest rates to stave off such a downturn. This sort of disruption is not terribly likely because, if for no other reason, it is not clear where this massive outflow of funds from the United States would go. Moreover, if it is a real problem, it is a problem associated with the high degree of integration of the world and is not a result of the trade deficit itself.

As with many other imbalances in the world economy, the imbalances in U.S. trade and investment will not go on forever. But they can be maintained for a long period of time. In 1975, who would have thought the U.S. would and could run trade deficits for the rest of the century?

Arthur MacEwan teaches economics at UMass-Boston and is a D&S Associate.

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